How Do Student Loans Affect Your Credit Score?

Gerard AnthonyApril 28th, 2017

Average college tuition in the United States is up by 42 percent in the past ten years and the total amount of student loan debt outstanding is up by 170 percent over the same period. As you prepare to manage your student loan debt, you need to understand the answer to a far-reaching question: do student loans affect credit score?

The answer is a definite “yes.” Student loan debt may be the first debt you have ever taken on and most likely will be the largest debt you’ve dealt with to date. How you handle this debt can have a huge effect on your credit score. Since that score determines your access to credit and the cost of that credit in the future, your student loan debt can set the tone for your financial future.

Your credit rating reflects the debts that you have and your repayment history. The key to a good credit rating is to make regular payments on time and pay off your debt as quickly as possible. With careful planning and financial responsibility, you won’t feel overwhelmed by your student loan.

Here are a few tips to help you effectively manage your debt so your credit is not negatively impacted by your student loan.

How Do Student Loans Affect Credit Score?

FICO, the most commonly-used form of credit score, breaks debt into two categories: installment loans and revolving credit.

Installment loans are those with a fixed schedule for paying down debt over time. Revolving credit includes more flexible kinds of debt, such as credit cards, for which balances can go up and down over time.

The key difference is that installment loans represent more of a commitment to making set payments on a regular schedule. With revolving credit, as long as you can meet a fairly modest minimum monthly payment, the pace at which you repay your debt can vary without you being considered behind. With installment loans, though, you have to make predetermined monthly payments of interest and principal that will work towards paying down your debt over time.

The thing to remember is this: if you don’t keep up with the schedule for your student loan payments, you will be considered behind on your debt and this will hurt your credit score.

Student Loan Payments: Missing and Late

Thinking of your payments as being on a strict schedule is central to understanding how those payments can afford your credit score.

Start by thinking about a train that runs on time every day. Just because you arrived at the train station ten minutes early yesterday does not mean you can afford to show up ten minutes late today and expect to still catch the train. The schedule has to be met day in and day out.

So, for example, you cannot afford to skip a student loan payment, even if you previously made an extra payment. If a payment that the loan company is expecting does not arrive, it will be considered missing and this will affect your credit.

Similarly, if your loans are due on the 15th of each month, it is your responsibility to make sure the lender receives them by that date. No excuses, and no margin for error. If a payment does not arrive until the 16th, it will be considered late and this will hurt your credit.

Student Loan Tips to Protect Your Credit Score

The following are some basic tips for preventing your student loan from damaging your credit history:

Make interest payments

Government-subsidized student loans typically do not require payments until you are out school, but not all student loans are like this. Some require that you at least make interest payments from the very start, while you are still attending school. These loans may offer you the option of deferring interest until after graduation, but since this means adding that interest to the principal of the loan, it will result in you paying more interest in the long run.

Understand what kind of loan you have, and when you will be expected to begin making payments. If it is not a government-subsidized loan, you may have to make interest payments while you are still in school. Factor this amount into your monthly budget and make payments on time.

Use the grace period

Upon graduation, you usually have a six-to-twelve-month period before you have to start repaying your loan. This time is designed for you to find a job that affords you some financial stability. If you get a job before your grace period is up, put some money aside before you have to start making those payments. This will allow you to make a larger payment at the start of your repayment period to reduce future interest expense or build a reserve of savings that will allow you to continue to make payments, even if you have a financial setback.

Pay it off as soon as possible

Most student loans give you 10 years to repay. The monthly payment that your lender requires is based on this timeline. If you can afford it, increase your monthly payment and pay your loan off sooner. Also, if you get a tax refund or bonus check, use it to make an extra payment toward your principal.

By paying more than the minimum payment, you will reduce your debt and pay off your loan faster. Not only will this lower the total interest you pay over the life of your loan, it will have a positive effect on your credit score.

One caveat: Interest rates for student loans are usually lower than for other types of debt. If you are carrying a significant amount of more expensive debt, such as credit card debt, put the extra payments toward that debt first. You’ll save money on interest in the long run.

Don’t skip payments

Contact your lender immediately if you’re having trouble making your loan payments. By communicating with your lender, you show a desire to cooperate, which makes lenders more willing to work with you to find a solution. You may be able to arrange an alternative repayment plan with lower payments over a longer term. You may also be able to defer payments for a few months, but remember your loan may continue to accrue interest.

If you can’t afford to pay the full amount, make a smaller payment to show a good faith effort. If you skip payments, your loan will be considered delinquent. This will show up as a negative mark on your credit report.

When you repay the loan, your credit rating should improve, but your missed payments will still be on your record.

Never default

Defaulting on your student loan can leave a stain on your credit history for up to seven years after your loan is paid in full. When you default, collectors will hound you for payments and may eventually seek legal action. Your lender can garnish your wages and your tax refunds in order to repay the loan.

If you declare bankruptcy, keep in mind that your student loans are not always forgiven. Government loans may still have to be repaid. A bankruptcy also remains on your credit report for seven to 10 years.

As with any money you owe — be it a credit card balance, a student loan, or a mortgage — your best bet is to make regular payments and try to pay the balance off as quickly as possible. Not only will this improve your credit score, but you’ll also sleep better knowing the debt is off your shoulders.

Can Shopping for Interest Rates Impact Your Credit?

Shopping for the best student loan interest rates is a smart move, because finding a cheaper rate will save you money for years to come. However, you have to shop around in the right way or else it could adversely affect your credit.

When credit agencies repeatedly receive credit checks about a consumer, it can look as though that person is frequently seeking to take on more debt. This may hurt your credit rating, but there are ways to shop for better rates without triggering this negative impact.

Rather than shopping for rates sporadically, if you have inquiries for the same type of debt within a two-week period FICO will recognize these as inquiries related to a single loan rather than multiple loans. Also, use online resources to compare rates without triggering a credit check, and talk to lenders about what are known as “soft inquiries” and a pre-qualification process that can size up your likely loan eligibility without a formal credit check.

How Can Refinancing Student Loans Help Your Credit Score?

Refinancing itself won’t directly improve your credit score, but if it helps you keep repayment on schedule by lowering your monthly payments, refinancing student loans can help you avoid damage to your credit history.

The best way to lower your monthly payments by refinancing is if you can reduce your interest rate. You can also lower your monthly payments by stretching repayment out over a longer period of time, but this is likely to result in you paying more interest over the life of the loan.

Student Loans Can Actually Help Your Credit

While you should be aware of the potential for student loans to hurt your credit, there is also an upside. Handled correctly, student loans can actually help your credit.

One of the challenges young adults face is trying to establish a credit history. This can be a catch-22: it is tough to qualify for credit without any payment history, and yet how do you establish that kind of history if no one will lend you money?

Often, student loans are the answer. They may be the first type of credit you can qualify for and, if you handle your payments responsibly, they will start to establish the kind of positive credit history that will give lenders the confidence to extend you other forms of credit – such as credit cards or a mortgage – in the future.

Bottom Line

Student loans will have an impact well beyond your years in college. Your payments will impact your budget, and your diligence in making those payments will impact your credit score. Handling this successfully comes down to understanding your responsibilities and following through on them.

The good news is that if you do that, your student loan could become the key that unlocks your access to affordable credit when you need it in the future.